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Distressed debt has been declining since February and hit its lowest level since 1998 this month. Distress in junk bonds decreased to 3.0 percent in mid-September 15, down from 3.1 percent in August, according to Standard & Poor’s Ratings Services.

A corporate bond is considered “distressed” debt if it has an interest rate that’s 1,000 basis points (bps) or more over its respective Treasury benchmark. The S&P distress ratio’s most recent high was in February at 5.7 percent, and averaged 6.1 percent in 2005 and 7.4 percent in 2004.

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“The number of issues at a hefty spread has sunk to lows we have not seen in a long time,” says Devi Aurora, director of Standard & Poor’s Global Fixed Income Research Group. According to S&P, 120 companies have bonds trading at distressed levels.

No surprise to anyone keeping up on business news, automotive companies feature prominently on the list of companies in the distressed speculative-grade bond market. For example, Ford Motor Co., Exide Technologies, Keystone Automotive Operations, and Metaldyne had distressed credits having 600 bps and 800 bps spread minimums as of September 15. Still, the automotive sector had some of the largest declines in the share of distressed credits in late summer. The telecommunications industry is also at the top of the list, followed by consumer products and media and entertainment.

While companies in health care, media and entertainment, telecommunications, and consumer products recently experienced an increase in distressed credits, another segmented group — retail companies and restaurants — has emerged as having distressed credits under 800 bps and 600 bps benchmarks.

S&P predicts that the speculative-grade default rates will reach 2.1 percent by the end of this year and 3.5 percent by the first quarter of 2008. Its expectation for the next four quarters is higher (2.4 percent) than the average default rate in the past year (1.9 percent).

The credit-rating agency has a slightly higher outlook on recovery rates, in the event of default, than last month. Across all debt types, S&P estimated the recovery rate to be 48 percent, compared to the predicted 45 percent in August. It expects the highest recovery rates in the telecommunications, retail/restaurant, media and entertainment, and high-tech industries. The aerospace/defense, transportation, and chemicals, packaging and environmental services sectors are expected to have low recoveries.